Dec 13, 2017

The Meaning of Manufacturing and Why it Matters

By Carlos Plaza

Earlier this year, President Trump signed a memorandum calling for a plan to ensure that work on new and existing pipelines be performed with “materials and equipment produced in the United States, to the maximum extent possible and to the extent permitted by law.”

This is welcome news given the precipitous decrease in American manufacturing jobs brought about by an increase in foreign competition over the last two decades. However, a close reading of the memorandum hints at another threat to American manufacturing. You see, the President’s memo specifies that products manufactured in the United States from semifinished steel of foreign origin, are not to be considered as “produced in the United States.” The question is, why would something made of foreign steel be considered American-made in the first place?

To answer that question we have to go back almost a century. That’s because, when it comes to buying goods and services, federal agencies must adhere to the Buy American Act of 1933. It says that “... only manufactured articles, materials, and supplies that have been manufactured in the United States substantially all from articles, materials, or supplies mined, produced, or manufactured in the United States, shall be purchased for public use.” However, in practice, iron and steel products can comply with the Buy American Act if they are “substantially transformed” in the United States. This interpretation allowed so-called “slab converters” to import and process foreign steel in American rolling and galvanizing mills and still sell the finished products as American-made. Hence, the need to spell out the restriction of this practice in the president’s memorandum.

Relying on terms like “substantially transformed” in order to claim that a product was made in America may seem like tricky word play, but it actually reflects the traditional definition of manufacturing. Back in 1933, it was assumed that a product had a single country of origin and that the main source of value was derived from the physical transformation of raw materials. Even today, the U.S. government defines the manufacturing sector as “establishments engaged in themechanical, physical, or chemical transformationof materials, substances, or components into new products,” as well as those engaged in “assembling of component parts of manufactured products” for purposes other than construction.

This chart shows the contribution of services to the total value added in products sold by the U.S. manufacturing sector in 2011. Services represent nonphysical activities such as software development, research, design, marketing, logistics, and information technology.

Unfortunately, this definition does not reflect our current reality. The rise of globalism over the last few decades has changed the face of manufacturing. Employees in several different countries are often involved in the creation of a single product and the amount of value added by the physical transformation of that product (manufacturing) counts for much less than it used to. For example, a 2008 study found that the cost of assembling computers and music players to be only 3% to 5% of the selling price. Another study showed that the physical manufacture of a Nokia’s N95 mobile phone came to only 2% of the final pretax sales price. In fact, the value of physical inputs, such as processors, cameras, and integrated circuits, are less than the value of Nokia’s intellectual property, in-house services, and profit connected with the phone.

The rapid pace of technological innovation has seen a decrease in the value of hardware such as processors and integrated circuits and a corresponding increase in the value of software. A growing portion of the value of many manufactured products, from pacemakers and washing machines to cars and airplanes, is created by software coders in offices rather than workers on the factory floor. Business services such as research, design, marketing, logistics, and information technology also represent a growing share of product value and employment in the manufacturing sector.

The problem is that the various provisions in U.S. law designed to support American manufacturing do not account for the geographic location nor the value added by many of the service workers currently involved in creating manufactured goods for U.S. companies. The benefits, preferences, or penalties prescribed by these laws are solely based on the country in whichphysical transformationoccurs. Therefore, a product cut, molded, or assembled in the U.S. can be deemed “Made in America” even if all research, design, software development, and other nonphysical activities are done in other countries.

The first steps towards addressing the issue take the form of a recent Congressional Research Service Report. The reportWhat is Manufacturing? Why does the Definition Matter?addresses the traditional definition of manufacturing and how it may hinder policies designed to support American manufacturing.